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Markets

Wall Street on Sale: Buyout Mania

Private investors spent nearly $400 billion in 2006 to acquire public companies. Look for more in 2007.


Steven Kaplan is a finance professor in the Graduate School of Business at the University of Chicago.

Kiplinger's: Why are so many deals being done?

Kaplan: Three things are driving the buyout boom. First is the amount of cash flowing into private equity firms. These investment pools have reported annualized returns exceeding 20% for the past three years, so a lot of money is flowing in -- rightly or wrongly -- from public and corporate pension funds, college endowments, other institutions and wealthy people. Second, banks are lending aggressively -- interest rates are low and terms aren't strict.

And the third element?

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CEOs are more receptive to going private than they were five or ten years ago. If they've been running companies well and honestly, onerous new regulatory requirements are a nuisance. Good CEOs are underpaid today relative to the grief they take from regulators, the media and big shareholders.

What do all these buyouts mean for ordinary investors?

If you're holding a stock that gets bought out, you'll get a 10% to 30% premium, on average, and there will be some upward effect on other stocks in the industry. But even the activity this year amounts to only about 2% of the market's value. It won't drive the entire market.

What kind of investments will these companies be when they reappear on the stock market?

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The positive answer is that buyout firms specialize in industries. They have the expertise to make the company more productive. The deal itself is a bit of shock therapy. There's an incentive to look at the company differently. Bosses can act without having to worry about next quarter's earnings. The other side is that private equity firms get lots of fee income whether deals succeed or not. So they will do deals with just okay returns.

How do you tell the difference?

It all comes down to cash flow. If companies are improving efficiency, there will be more cash flow and operating income.